Making Consignment Work
July 1, 2010 One of the distinguishing traits of a merchant – as contrasted to domestic suppliers and free on board (FOB) sellers – is the omnipresent ability to source and deliver many types of cotton to virtually any buyer, on any terms, anywhere. Making foreign delivery draws upon the special skills, experience and capital of the full-fledged cotton merchant.
And when the delivery is made by consignment sale, it takes a team effort of the merchant, his cotton insurer, banker, warehouseman, and controller – all with the merchant as team leader. Without the confluence of these efforts, positioning of unsold/unpaid cotton for the convenience of mills would be a risky endeavor. Not every shipper has the will or resources to position unsold/unpaid cotton abroad for the convenience of mills. But there are benefits. Using consignments, the merchant may:
● Be able to lock in better margins and/or better hedged forward sales;
● Be able to overcome reduced vessel capacity/frequency otherwise straining mill operations;
● Be able to take advantage of quotas, either as export subsidies or import controls;
● Have a unique and superior foreign exchange position compared to buyers in a certain country;
● Have a better credit line than the mills, and most important of all,
● May preempt, freeze out, or unnerve the competition.
Using a military analogy, consignments are like operating on the “other side” of the front line, where the possibility of casualty looms larger. It can be a very useful tactic in an overall strategy, but only when your team – cotton insurer, banker, warehouseman, and controller – makes it back safely and profitably. Especially now, when credit, logistics, and demand exposures are more difficult than at any time in recent memory, merchants, bankers, warehousemen, and controllers as risk takers must operate on the “buddy system.”
For insurers such as Rekerdes & Sons, the initial green light for consignments turns on one simple proposition: what evidence is there of the merchant’s export experience? Some obvious signs:
● A long and successful (low claim) record of normal exports;
● Long-term relations with known trade banks;
● Uses Quality A+ Carriers;
● Uses a registered trading contract form and terms;
● Active in merchant trade association(s) and has a robust reputation in the marketplace.
Before the merchant’s own team closes in on a short list of suitable warehouse candidates, insurers want to review physical characteristics and warehouse procedures, other customers, recourse available via tariff or local cover, and most important of all, whether the warehouse understands and wants cotton business.
Other team members include bankers and controllers. Bankers should have a clear understanding of the cotton terms, deductibles, and exclusions. Bank credit line covenants should be examined, as well as laws governing the marine risk to delivery and the on-going property risk at consignment locations. One must consider: are there requirements for local insurance?
As insurers, we want to know who in the merchant’s office will keep the book on values, sales and stocks and to make certain they understand our reporting system. Will local sales and release of goods be handled by venerable agents or trusted employees? Does the controller inventory/audit stocks and check the bales on cotton being received?
Since the 1920s, many cargo and not a few cotton losses have arisen from consignments. Fortunately, most were properly claimed and paid in full. But recently, and especially in respect of storage, three troubling patterns have emerged:
● In respect to delivered sales, some merchants/insurers fail to re-assert title or re-attach merchant cover.
● Some insurers simply qualify “All Risk” so as to exclude theft by mysterious disappearance.
● Claims fail because the merchant has no third party or system to broadly reconcile consignment inventory against sales and shipments.
Unless the merchant is strong enough to intentionally carry the goods at the foreign location, consignments are a bad idea. Once the merchant’s strength is confirmed, and assuming we can confirm a fine physical warehouse, and assuming there is no mysterious disappearance exclusion, then it is time for proper inventory procedures to bear fruit. For example, we usually charge premium on bales reported on hand each month and on monthly sales. But in the event of loss, these insurance reports alone will not symbolize a reconciled inventory – the true risk beginning point.
Lessons from the “Metro”
In 1998, vast quantities of crude oil (US $200 million-plus) were discovered missing from the “Metro,” an offshore consignment storage facility. The loss was abetted by sloppy record keeping, which led to the initial claim declination based in part on the failure to reconcile stocks to shipments. Though “Metro” (plus some 35 related cases) languished for years in English courts, ultimately “Metro” was decided in favor of the merchant. The legal expense alone is estimated at over US$35 million.
Our small cadre of commodity underwriters suffered severe whiplash. Even 13 years later (a small blip in commodity insurance time) we find the “chips” are still falling. Understandably, the insurers who remain now insist on detailed foreign stock-keeping procedures plus fluent disclosure and real experience.
The calculus for cotton consignments appears to have arrived again. However, given today’s high cost of new capital and tight job market, commodity underwriters and bankers are reined in like never before.
We expect that this time merchants will assemble reliable warehousemen and controls with actual assets and real underlying insurance. Merchants must work with bankers who will capitalize the benefits of “loss payable endorsements” into useful collateral lines.
GET THE NEWSLETTER TODAY!
